June 29, 2011

WSJ: The 'Brady Bond' Solution for Greek Debt

How much for the island of Mykonos? The Mexican standoff between European banks owning Greek debt and Greek taxpayers needs fresh thinking. I'm convinced that the only way out of Europe's financial crisis is for Germany to essentially own Greece.

How did we get here? Start with this: European accounting rules allowed Greek and other sovereign debt to be viewed the same as cash on European bank balance sheets. These bonds count toward a bank's capital base and new loans can be written against them without changing a bank's loan loss reserves.

Given this preferential treatment, and insured against default with good old credit default swaps, way too many increasingly worthless Greek bonds are now stuck inside German and French, and of course Greek, banks. Because of out-of-control government spending and entitlements, some half a trillion of Greek debt, 150% of the country's gross domestic product, is scattered throughout the world.

backed by utilities, railroads, tourism, Ouzo factories and maybe even the islands of Santorini and Mykonos.

Of course Greece wants to default so it can start over again. Who wouldn't? But the Germans won't let them default, as that (and subsequent defaults in Italy, Spain and Portugal) would send virtually every European bank into insolvency. I don't know if these banks are carrying Greek debt at face value—they won't say. But a good bet is the bonds are not marked to market, which today might be 50 cents on the euro. U.S. insurer Aflac has already written down almost $1 billion in losses from sales of European debt. A stress test of Europe's banks is due in July. We'll see who fesses up.

So the Germans push for austerity, a much-needed cutback of pay and benefits and even jobs to the 25% of Greeks who work for the government. (What's a Grecian urn? Way too much!) In response, the Greeks riot.

One hard lesson of the post-Lehman Brothers world is that there is no way Greece will be allowed to default, much as Citibank and Bank of America were not allowed to default at the height of the U.S. financial crisis in 2008. The way I see it, the endgame will be something like the Brady Bonds devised in 1989 by U.S. Treasury Secretary Nicholas Brady to resolve the Latin American debt crisis, but with an equity twist.

Under the Brady Plan, bad sovereign debt was swapped for new U.S. government-backed bonds with various interest-rate structures, making them tradeable and easy to move off of bank balance sheets. Ecuador defaulted but Mexico retired their Brady Bonds by 2003, as did eventually most of the dozen plus other Latin American countries.

Greek Prime Minister George Papandreou (left) with French President Nicolas Sarkozy and German Chancellor Angela Merkel.

Euro-zone finance ministers plan to meet again this Sunday to address the Greek tragedy. But so far the only plan on the table is a doomed one by the French for the voluntary restructuring of sovereign Greek debt. Private buyers are increasingly skeptical of government guarantees and will demand real collateral. Credit default swap derivatives, which merely spread the risk, will no longer do. Some other sweetener will be needed. The solution? Bonds backed by real Greek assets.

In this case, you would convert Greek debt, denominated in euros, into long-term German bonds backed partially by the good faith of the German government but also backed by Greek assets—you know, utilities, railroads, tollways, airports, cellphone services, tourism, Ouzo factories and maybe even the islands of Santorini and Mykonos. If (some say when) the Greeks default, the Germans or new bondholders end up with the assets, much like in a home foreclosure. You don't know what bond buyers will demand until you try to sell them this new debt. Maybe they'll want equity ownership along the way, say, 5% ownership transfer every year for 20 years. It's all up for grabs.

The effect would be that these new bonds could be structured to trade near par or face value today, backed by both a strong Germany and real assets. European banks would be saved. These "Brady Bunds" or "Bund Bonds" or "Merkel Bonds" would freely trade and banks could sell them off to clean up their balance sheet, much as the original Brady Bonds.

The Greeks would have a decade to work things out. Austerity would be brought on slowly but surely, and if there were defaults it would happen quietly with asset transfers along the way to Germany (or hedge funds or China) who would end up owning this new Greek instrument. The new owners would then go in and rationalize each business and fire whom they must to make each enterprise profitable, in private versus public hands. This is an old trick of U.S. manufacturers, sell an old factory to someone else and have new, unknown owners fire the workers.

U.S. Treasury Secretary Tim Geithner is too distracted with our own debt-limit arm wrestling to pull this off. Here's hoping there's someone strong enough in Europe to do for Greece—and by extension the entire euro-zone—what Nicholas Brady did for Latin America.

Comments

To repay the debt, why couldn't Greece first designate an island as a Charter City (www.chartercities.org)? Then, leasehold rights to develop the site as a Hong Kong or Shenzhen of Europe could be auctioned, with proceeds paying off IOUs as a debt-for-equity swap. The winning developer(s) of the charter city concession would be obliged to respect a Build-Operate-Transfer framework conveying improved real estate and infrastructure assets - over a pre-set period - to every citizen of Greece who agreed to forego future claims to entitlement payments.

Rather than telling the Greeks how to solve their problem, how about some practical wisdom to get US back on track? Can you ask Steve Forbes to get off the Flat Tax track and endorse a zero percent corporate income tax to really create

JOBS, JOBS, JOBS
by
Stephen Uhl, Ph.D.

As our unemployment rate hangs above 9% nationwide the loud cry for more jobs becomes more and more urgent, even angry—and legitimately so. The angry impatience of the unemployed and underemployed demands a practical response from government and industry; human compassion drives the rest of us to work for drastic improvement in the employment picture.

Companies large and small are the real job creators.

As Tom Braithwaite wrote in The Daily Progress (2/22/2011), there is great need to reduce costs of doing business in the United States. He pointed out that companies are currently overburdened with both regulations and taxes; these expenses are naturally embedded in the prices that companies have to charge for their products. Since corporations are taxed more heavily in U.S. than in any other country but one, and since complex tax regulations burden our productive corporations so heavily, international companies are highly motivated to leave profits offshore where they are not taxed up to 35%.

Since international companies can produce more cheaply offshore while selling to the world's largest market (U.S.), we go begging for jobs as we contribute to the serious export-import imbalance. Up to $13 trillion of overseas business remains overseas while great companies like Microsoft, G.E., Cisco, etc. hire foreign workers and leave their huge profits offshore---to a great extent to avoid paying U.S. income taxes. As Mr. Braithwaite brings out, with reasonable regulations and no corporate income taxes we would likely enjoy full employment here on our shores. FairTax (H.R. 25 & S. 13) would accomplish this.

The former Head of the U.S. Ways and Means Committee, Bill Archer, asked Princeton University Econometrics to survey 500 European and Asian companies for the effects that FairTax would have on their business decisions regarding locating in U.S. An impressive 400 companies indicated that they would locate their next plant in the United States if The FairTax were enacted; the other 100 companies said they would even go further and move their headquarters here (Footnote #64 for FairTax Wikipedia article). Surely this indicates that if FairTax were enacted full employment would quickly follow in U.S.

Certified Financial Planner, Ken Clark, in The Idiot's Pocket Guide to The FairTax, p. 103, writes: “The FairTax's most legitimate chance to contribute to economic growth comes from its ability to change the balance of U.S. foreign trade... U.S. goods will finally be able to compete on equal footing with foreign goods, something the current tax code impedes.” This same Certified Financial Planner goes on to point out that under FairTax “... imported goods will lose any tax-based price advantage they had, increasing the demand for some domestic alternatives. In turn, this would keep more money in our economy, which can result in a stronger economic bottom line.” (p.105)

Full employment results as MADE IN AMERICA becomes popular once again.

An increasing volume of research makes it ever more clear that the current I.R.S. Code (some 70,000 pages) of complex systems of loopholes and political favoritism cannot be fixed; it needs to be totally replaced. Being income based as it is, it taxes the conscientious while being so gameable that about 50% of Americans do not contribute to carrying the tax burdens. The underground economy of perhaps 1.5 trillion dollars currently goes untaxed. Under the proposed FairTax, all corporate and individual income taxes are replaced by a simple federal sales tax of 23% on all new purchases above the poverty level; the poor are left untaxed altogether.

Below is a very tight summary of some of the highlights of FairTax:

What is the FairTax plan?

The FairTax plan is a comprehensive proposal that replaces all federal income- and payroll-based taxes with a balanced approach including a progressive national retail sales tax, a prebate to ensure no American pays federal taxes on spending up to the poverty level, dollar-for-dollar federal revenue neutrality, and, through companion legislation, the repeal of the 16th Amendment.
The FairTax Act (HR.25, S.13) is nonpartisan legislation. It abolishes all federal personal and corporate income taxes, gift, estate, capital gains, alternative minimum, Social Security, Medicare, and self-employment taxes and replaces them with one simple, visible, federal retail sales tax administered primarily by existing state sales tax authorities.
The FairTax taxes us only on what we choose to spend on new goods or services, not on what we earn. The FairTax is a fair, efficient, transparent, and intelligent solution to the frustration and inequity of our current tax system.
The FairTax:
-Enables workers to keep their entire paychecks
-Enables retirees to keep their entire pensions
-Refunds in advance the tax on purchases of basic necessities
-Allows American products to compete fairly
-Brings transparency and accountability to tax policy
-Ensures Social Security and Medicare funding
-Closes all loopholes and brings fairness to taxation
-Abolishes the IRS.
The details of FairTax (H.R. 25 & S. 13) can be found in an increasing abundance of sources beyond the pocket guide mentioned above. For introductory concepts the reader can go to www.FairTax.org and www.fairtaxnation.com. Another rich and concentrated source of information is FairTax: The Truth: Answering the Critics, by Boortz. Many varied sources can be found by simply Googling FairTax. For the more legal minded, the 130 page proposed law is readily available via internet.